NORTHERN TRUST CORP quarterly report, Q2 FY2017

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Business context and reporting period

Northern Trust Corporation filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2017. It provides asset servicing, fund administration, asset management, fiduciary and banking services through Corporate & Institutional Services (C&IS) and Wealth Management; Treasury and Other contains corporate and treasury activities.

Financial performance and position

  • Second quarter: Revenue was $1.321 billion, versus $1.317 billion a year earlier. Net income was $267.9 million, up 2%; diluted EPS was $1.12, versus $1.10. Income before taxes was $390.8 million, down 1%.
  • Revenue mix: Trust, investment and other servicing fees rose 9% to $848.2 million; net interest income rose 14% to $341.5 million. Foreign exchange trading income fell 22% to $49.9 million. Noninterest income declined 4% to $979.7 million, largely reflecting the absence of a prior-year Visa-related gain.
  • Margins and returns: Net interest margin was 1.28% on a fully taxable equivalent (FTE, non-GAAP) basis, up from 1.16%. Return on average common equity was 11.6%, compared with 12.3%; return on average assets was 0.91%, compared with 0.92%.
  • Expenses and credit: Noninterest expense increased 1% to $937.4 million and included $22.8 million of severance and related charges. Provision for credit losses was a $7.0 million credit. Nonperforming assets were $166.7 million; net charge-offs were $3.2 million.
  • Six-month results: Revenue was $2.606 billion, up 4%; net income was $544.0 million, up 7%; diluted EPS was $2.21, versus $2.13. Net interest income rose 14% to $695.0 million, while noninterest expense rose 4% to $1.832 billion. The credit-loss provision was an $8.0 million credit.
  • Balance sheet and funding: At June 30, assets were $125.6 billion, deposits $104.3 billion and stockholders’ equity $10.1 billion. Loans and leases were $33.5 billion; securities were $43.4 billion; Federal Reserve and other central bank deposits were $29.0 billion. Reported borrowings included $4.1 billion of other borrowings, $1.5 billion of senior notes, $1.7 billion of long-term debt and $277.5 million of floating-rate capital debt.
  • Cash flows, six months: Operating activities provided $312.6 million, investing activities used $298.0 million and financing activities provided $184.1 million. Cash and due from banks ended at $5.7 billion. Cash flows were affected by collateral movements, central-bank deposits, securities activity, deposits, debt issuance, dividends and share repurchases.
  • Capital and client assets: Corporation CET1 ratios were 13.2% under the Advanced Approach and 12.3% under the Standardized Approach; management said capital exceeded well-capitalized minimums. Assets under custody/administration were $9.294 trillion, up 9% from year-end 2016; assets under management were $1.029 trillion, up 9%.

Material changes versus prior comparable periods

  • Quarterly servicing fees and net interest income grew, but lower FX income and the nonrecurrence of the prior-year Visa gain restrained reported noninterest income and total revenue. Excluding specified prior-year items, management reported quarterly revenue growth of 8%.
  • Prior-year quarter items included a $118.2 million net Visa share-sale gain, a $46.5 million securities-lending litigation settlement charge, $18.6 million of C&IS client-contract modification charges, and other severance and portfolio impairment charges. The current quarter included $22.8 million of severance and related expense.
  • Higher short-term rates and lower premium amortization helped lift net interest margin; average earning assets rose 3% year over year. Interest expense also increased, including higher deposit costs.
  • Quarterly segment net income was $147.5 million for C&IS (up 71%) and $139.5 million for Wealth Management (up 17%). Treasury and Other recorded a $19.1 million net loss, compared with $58.0 million of income a year earlier, primarily reflecting the prior-year Visa gain.
  • For the six months, cash from operating activities improved from a $507.2 million use in 2016 to $312.6 million provided in 2017; investing cash use fell from $4.930 billion to $298.0 million.

Outlook, risks, contingencies and unusual items

  • The filing provides no quantified earnings or revenue guidance. Management cited market-sensitive fee income, interest rates, client flows, expense control and continued business growth as factors affecting results.
  • Northern Trust agreed to acquire UBS Asset Management’s fund administration businesses in Luxembourg and Switzerland for an initial cash purchase price of approximately $175 million, subject to adjustment. Closing was expected in the second half of 2017, subject to regulatory, fund-board and customary approvals.
  • Illinois enacted a retroactive permanent corporate tax-rate increase effective July 1, 2017. The company expected a higher effective tax rate in future quarters and a one-time, noncash tax expense from remeasuring Illinois deferred tax liabilities; the filing did not quantify that charge.
  • Interest-rate sensitivity estimates showed next-12-month net interest income increasing $24 million under a gradual 100-basis-point rate rise and $39 million under a 200-basis-point rise. Estimated market value of equity increased $298 million and $323 million, respectively, under those shocks. Management cautioned that the models rely on assumptions and omit mitigating management actions.
  • Legal and regulatory matters: management said pending matters were not expected to materially affect consolidated financial position or liquidity, though they could materially affect a period’s operating results. Estimated reasonably possible aggregate loss was $0–$35 million, excluding matters for which a range could not be estimated. The French estate-tax case had resulted in acquittals, but the prosecutor appealed. Visa interchange-fee litigation remained unresolved and could affect conversion timing and value of retained Visa Class B shares.
  • Other risks include market and FX volatility, credit quality, cybersecurity and operational failures, regulatory and compliance costs, liquidity and counterparty risks, litigation, and the effect of equity markets on fee income. The filing reported no material change in internal control over financial reporting and concluded disclosure controls were effective.

Important facts for investors to verify

  1. Whether growth in servicing fees and net interest income can offset continued FX-income weakness and rising compensation, technology and operating costs.
  2. The underlying earnings trend after separating current severance costs and prior-year Visa gains, litigation settlement and other unusual charges.
  3. Deposit composition and pricing, interest-rate sensitivity, and the sustainability of the 1.28% quarterly FTE net interest margin.
  4. Credit trends, particularly residential real estate’s 81% share of nonperforming loans and leases, and the adequacy of the allowance.
  5. Completion, final cost and expected contribution of the UBS fund-administration acquisition, and the actual effect of the Illinois tax change.
  6. Developments in Visa litigation, the French appeal and other contingencies, including exposures not included in the disclosed loss range.